Drop in price of gold sets off rally that pushes 30-year back to 6.96%.

The Treasury market bounced back yesterday when a drop in the price of gold lured retail investors back into the market.

The rally pushed the long bond back below the 7% level that it had broken through during Tuesday's sell-off.

Late yesterday, the 30-year bond was up more than 1/2 point on the day, and a full point above the session lows, to yield 6.96%. Note prices were up 1/8 to 1/2 point.

The market started off the day on the wrong foot. Prices declined in early New York trading as gold prices moved higher, and traders said Commerce Secretary Ron Brown's call for a weaker dollar against the yen was another negative factor.

Tony Crescenzi, head of fixed income at Miller Tabak Hirsch & Co., said the market's recovery started late yesterday morning when it became clear the Federal Reserve had not signaled any tightening in monetary policy.

The big gains reported last week in April consumer and producer prices had led to speculation that Fed policymakers might tighten at Tuesday's Federal Open Market Committee meeting. But the Fed stayed out of the market at Fed time yesterday, indicating that it was still targeting a 3% funds rate.

At about the same time, gold began to come off its sessions highs.

By late yesterday, gold was quoted at $373.25 an ounce, down $1.05 from Tuesday's close, after having been up more than $7 on the day at the session highs.

Retail investors have stayed out of the market during the recent sell-off in Treasury prices. Crescenzi said the combination of a stable Fed policy and the weakness in gold convinced accounts that it was safe to buy Treasury paper again.

"They wanted a reason to jump in," he said. "They found a reason when the Fed didn't do anything and gold dropped."

Traders said the attractive levels on Treasury paper was another reason retail investors got involved yesterday.

"People kept their money on the sidelines last week and now that prices are much lower, people are starting to put some money to work," a government coupon trader said.

In addition to interest from retail accounts, there were reports that a big leveraged account sold gold and bought Treasuries. There was also buying for municipal defeasance deals, traders said.

The final surge in prices in mid-afternoon had a lot to do with short-covering, traders said.

"Once you got to a certain level, like bonds above 101.13, you really got some bad shorts in the market and it just got worse as the market got higher," a note trader said.

Crescenzi said the market should continue to move higher today because some investors probably missed yesterday's move.

But he said the upside is limited given the market's worries about inflation and deficit reduction, and predicted the gains would stall once yields fell another eight to 10 ticks.

The note trader was less sanguine. He said the market now harbors bad short positions from the last couple of days' trading, along with the bad long positions from last week's auctions, and predicted that would make for erratic trading.

The Treasury market hit its lows after yesterday morning's merchandise trade report showed the deficit surged to $10.21 billion in March from a revised $7.9 billion February gap.

The Commerce Department report was a surprise to the bond market, which had expected a $7.6 billion March deficit. The deterioration in the trade balance occurred as a 9.7% rise in imports outpaced a 5.6% increase in exports.

Analysts said it would be a mistake to interpret the surge in imports as a sign of strength in the U.S. economy. Other indicators have shown that domestic demand was lackluster during the first quarter, they said.

Douglas Schindewolf, a money market economist at Smith Barney, Harris Upham & Co., said about 35% of the increase in imports was in consumer goods. He said some of those imports may have contributed to the buildup in inventories that occurred in the first quarter.

"A lot of these orders were probably placed late last year or early this year, when there was more optimism about consumer demand," Schindewolf said. "So we don't see that as a sustainable level [of imports]; we think it will trail off."

Economists said the bigger-than-expected March trade deficit will result in a downward revision to first-quarter gross domestic output, and that should have been a plus for the bond market.

Instead, the trade report indirectly resulted in lower bond prices to midmorning when it elicited a call for a lower dollar from the commerce secretary.

If the dollar weakens further against the yen, it could scare Japanese investors away from the Treasury market, and a weaker dollar also has inflationary implications, traders said.

The Treasury said yesterday it will sell $15.75 billion of two-year notes on Tuesday, which is a $500 million increase from the April auction, and $11 billion of five-year notes on Wednesday.

Late yesterday, the when-issued two-years were yielding 4.03% and the when-issued five-years were quoted at 5.24%.

The June bond futures contract closed 5/8 higher at 110 9/32.

In the cash market, the 7 1/8% 30-year bond was 18/32 higher, at 101 28/32-101 30/32, to yield 6.96%.

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